Secondary Market Sale
Key things to know/consider/prepare for if your company allows secondary market sales
Pre-Read: Key Questions This Article Answers
Can I sell my pre-IPO stock on a secondary market?
As an employee, what are the key considerations, decisions, and risks of selling shares on the secondary market?
I'd like to try to sell some pre-IPO shares on a secondary market; how does it work and what should I do?
What It Means When Your Company Allows Secondary Market Sales
When a tender offer is conducted, most times it is company supported/driven but facilitated by a secondary market exchange. This can lead to come confusion regarding what a secondary market sale is (and how it differs). We define a secondary market sale as the sale of company stock that is not facilitated by your company.
It frequently surprises technology workers of pre-IPO companies (as it isn't something that is internally announced or generally known), but a number of pre-IPO companies allow their employees to sell their shares on private markets. Definitely not all, but especially as companies get larger in size, it's common for a company to have a policy of either (1) authorizing, or (2) not authorizing the transfer (i.e. sale) of shares. If your company is one of the first group (authorized), then you likely have the ability to sell or exchange your shares in your pre-IPO company. For a list of leading vendors, see: Private Market Exchanges and Brokers and/or Pre-IPO Exchange Funds
A secondary market sale usually has a number of steps: (1) You contact an exchange, broker, or exchange fund to see if they facilitate transactions in your company stock, (2) if they do, they'll likely provide you with current market pricing and you decide if/how much stock to list for sale, (3) your shares are then marketed/listed for sale (or if an exchange fund, jump to the next step), (4) you align on a deal/price (which may involve negotiation), (5) your company needs to approve the transfer, and in nearly all cases has a right-of-first-refusal, (6) assuming all is good, you'll complete paperwork and your sale will transact.
A secondary market sale is typically only able to be facilitated for large pre-IPO companies (typically $1b or more in value). Below that valuation, there is typically not enough of a "market" to be made.
Why Do Companies Allow Secondary Market Transactions
Secondary market transactions have both pros and cons associated with them.
On the negative side, pricing is not something the company can control (which could have adverse effects), the sale of shares could inhibit the company's ability to raise VC funds, it's possible that the sales could impact 409a pricing, sales could expand a company's investor base, and they require the company to take administrative action.
On the positive side, secondary market transactions or exchanges provide employees (and founders) with a path to liquidity, which is a big positive. The effort required is materially less than it typically is to setup/facilitate a tender offer, so some companies opt to allow them.
How a Secondary Market Transaction Impacts Your Stock Comp
The occurrence of a secondary market transaction by anyone other than yourself should not have an impact on your stock-comp. Should you choose to pursue a sale (or swap via a pre-IPO exchange fund) yourself, however, it will obviously have an impact. The impact depends on the route you pursue and the type of equity compensation you select.
Key Decisions, Considerations, and Risks
Should You Sell (or Exchange) Your Pre-IPO Shares?
This is a major decision, which heavily depends on your company, your personal circumstances and your financial situation/goals. There is a lot to consider to come to an answer here (and where partnering with an advisor can help). But at a high level, key items to assess are:
Is your company large enough? As noted above, most companies under $1 billion in value (and nearly all under $500 million in value) do not have a market/cannot be sold on a secondary market.
Do you know if your company approves (or does not approve) transfers? Every private market transaction will ultimately need to be approved by your company. Some companies have policies of approving these, others don't (its rarely "case-by-case").
What are your financial goals? How would the proceeds impact your financial desires, goals, and needs?
Do you want/need money now? If so, the liquidity could be very valuable to you. When a company is privately traded, you never know if a future selling opportunity will occur again; nor if one does occur, when that will be and at what price.
Do you believe the price you will get is fair? The price for pre-IPO company shares can be all over the place, and you may think the price shares are currently transacting at is fair, or not. It’s almost always subjective and in most cases really hard to determine. To help think this though, we recommend reading:
If You Participate, What Shares/Options/Tax-Lot(s) Should You Sell?
Let’s say you’ve decided to sell 10% of your shares. The next question = which shares should you sell? In some cases this is pretty straight forward (e.g. you have one NSO grant and have never exercised before; so you only have one choice).
But if you have an alphabet soup of stock grants (RSAs, NSOs, ISOs, RSUs), and have exercised at least a portion of your option grants, there is a lot to consider and optimize for. Each individual's situation is different, but some key things to consider are:
Do you have any shares that will qualify for QSBS when you sell? Or do you have any shares that will qualify for QSBS in the future if you continue to hold them?
If you have exercised ISOs, have the shares met the requirements for a qualifying disposition
If you have exercised NSOs, have the shares been held for 1 year (in which case gains since the purchase will likely be taxed as long-term-capital-gains)?
Strategic Tax Planning
With any liquidity event, a large number of tax planning opportunities exist. We've dedicated a section of this knowledge base site to detail 50+ tax strategies that you may consider, and highly recommend that you visit it as you develop your holistic plan and tax strategy.
Stock Comp Tax Planning Guide: 50+ Tax Strategies
That said, to try to be helpful, a few key items to consider are:
If you exercise options and sell shares in the same transaction, you’ll likely pay ordinary income tax rates on any gain. Note: this could push you into a higher tax bracket for the year. For more details see NSO Taxation and/or ISO Taxation.
If you sell shares you already own, you’ll likely pay capital gains taxes on any increase in value. The rates depend on whether you’ve held shares for over a year (long-term) or less (short-term). Long-term gains have lower tax rates (unless the tender is Compensatory; see below). For more details see Hold For 1 Year (Long Term Capital Gains)
If you sell ISO-acquired shares, make sure you consider if the sale will meet all the requirements of a qualifying disposition (or not) If you are exercising and selling ISOs in the same tender offer transaction, you'll pay ordinary income and/or short-term capital gains instead of long-term capital gains. For more details see ISO Taxation.
Important Weird Nuance: "Compensatory" tender offers: If the tender offer deal is classified as “Compensatory”, watch out! The gains above your company’s 409a valuation are likely to be taxed as ordinary income, even if you are selling shares you've owned for years (yep, really frustrating!). Your company should be able to provide you with this information (but make sure you ask)!
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